The Real Societal Cost of Paying with Plastic

Where is the stability in an economy that revolves around the acquisition of debt? Have we unwittingly, perhaps complacently, become so dependent on credit cards that we no longer see our national addiction to debt for what it is?

If the title of Robert Manning's book, "Credit Card Nation: The Consequences of America's Addiction to Credit" (Basic Books: 2000), seems to phrase the problem in exaggerated terms, then consider the real numbers: U.S. consumer debt is now at an astonishing $6.5 trillion, surpassing the federal debt of $5.8 trillion, which itself tops the nation's total corporate debt at $4.3 trillion. It's a "triangle of debt" that seems to threaten the very future and economic security of the nation. To make matters worse, the situation is compounded by a negative national savings rate, banking deregulation and conglomeration (starting in the Reagan-era 1980s and accelerated by the 1999 Financial Services Modernization Act), and the erosion of real wages and job security.

Today, there is no disputing that credit cards are everywhere. No less than 158 million Americans now own 1.5 billion shiny pieces of embossed plastic, ranging from retail cards to gasoline cards. Once the privileged possession of the credit-worthy and the employed, credit cards now jut out of the wallets of unemployed college students and Social Security-dependent elderly persons.

Credit cards have become the currency of our culture, argues Manning, helping us acquire the things we might not otherwise afford, masking our financial woes and sinking us further and further into the enveloping pit of debt. Manning has harsh words for the strategic marketing tactics of the credit card industry, but his strongest outrage is reserved for the largely unregulated predatory lending practices that have been unleashed on low-income communities across the nation.

We spoke to Professor Manning, a Senior Fellow of the Institute for Higher Education Governance and Law, University of Houston Law Center, to learn more about his impetus for writing about this crucial problem.

Why did you write Credit Card Nation?

I think there's growing national and public sentiment that the [credit card/banking] industry is out of control, and I was hoping that this book would provide some guidance on why [people] should be angry and why they should be afraid.

[All of this is] happening so fast, and the [credit] industry has presented it in a very individualistic manner. They have been pretty successful in making sure people don't see the larger picture. [They present] the whole moral underpinning of the dramatic increase in consumer credit as an individual decision and individual cost, and if you play, you pay. In other words, if you don't want to pay 24 percent interest, you don't have to.

You explain throughout your book that the transformation of America's Puritan-influenced ethos of thrift and savings toward an attitude that embraces the regular use of credit -- and that makes debt or even bankruptcy commonplace -- was one of the most important "cultural revolutions" of the postwar era. What were some of the key factors that contributed to this transformation?

Number one was sustained high rate of inflation in the late 1970s. The double-digit rate of inflation during the Carter administration made it economically rational to be in debt ... [A]s wages stagnated and started to fall in the late 70s, being in debt to pay off your washing machine or your car was financially feasible ...

At the same time, this is when the banks finally got deregulation, and they were not prepared for it. That's when they got clobbered by their third world loans, their bad real estate investments, and the recession of 1981-82 hit [during Reagan's presidency]. It was kind of like a purging.

It was a shakeout period. That's when banks realized that retail [financial] services would work, although in the past they were looked down upon ... That's where the confluence really hit. Low wages, high inflation, banks desperate for new markets, and people willing to pay unprecedented high interest rates for credit cards.

Banks then shifted their resources into marketing, going after displaced middle and working class people. People losing their jobs during the industrial restructuring were specifically targeted for credit cards, where before they would not have been approved. Banks transformed their underwriting criteria -- instead of only approving customers that will repay their loans, they now see that their prime market are customers that cannot repay their loans. That's this whole, fundamental shift from installment loans to revolving credit, where real money is finding people who will never repay. All of that occurs in that very brief period of time.

[W]hen the credit card companies got so successful, they started to buy each other out and then selling their credit card debt to insurance companies ... And once they realized they weren't holding all the risk anymore, then they realized, hey, we can loan to anybody because we [might] get hurt, but it's not going to be a disaster.

At this point, insurance companies are diversifying and instead of buying treasury notes, now they're buying secured rights to credit card debt ... [So], banks do the processing, they get the merchant fees and all that. And after they've gotten a good chunk of the money, they transfer the entire risk to these other companies that are buying credit card debt.

It's very extraordinary for them, because they can go after much more risky sectors of the market, whereas before they would never have done that. You've got to give these guys credit, they've got some of the most sophisticated marketing campaigns you could ever imagine and they're darn good.

When did the aggressive credit card marketing to college students really start?

The late 1980s. That's why I argue that it is so critical in terms of the transformation of American attitudes because what they have done is turned on its head the social responsibility [previously] associated with credit and debt. Before, you were only getting credit if you had proved yourself worthy by having a good credit history or by having job ... now the industry has allowed people to get credit without ever having a job.

Banks are having a more profound influence on this generation's attitude toward debt. Now it even can precede the influence of parents ... these attitudes are shaped prior to parents being able to teach what is good [debt] and what is bad debt.

Even during the slight dip in bankruptcy rates over the last two years, people 25 and under showed a sharp increase in bankruptcy. Using the term "graduating into debt" is now "graduating into bankruptcy." There are people just a couple of years out of college who can't pay their bills because of credit card debt.

You've made the point in your book that credit-using lower and middle classes are essentially subsidizing what you call the "free credit" of more affluent groups. How does that work?

The bottom line is that there's no real reason why people who pay off their credit cards at the end of the month should get zero or three percent interest. The reality is that if someone pays off their debt at the end of the month, they forget that the cost of borrowing that money, from the credit card company's perspective, could be anywhere from 4-7 percent.

They think they're being frugal when they pay off their credit cards. If they charge an average of $1,000 a month, it'll cost the company five percent ... and that means that the people who don't pay [off their credit cards each month] have to pay triple [in interest rates]. That's the way that industry has played upon this Puritan ethos in terms of giving credibility to the moral divide. People who get a free ride are those who need it the least, and people who have to pay exorbitant rates are those who need it the most.

That is part of the public discussion that people don't want to go into. I get angry emails on that. "How dare you say that poor people are subsidizing me?" It goes back to this issue of individual responsibility, that if you assume responsibility and pay it off that somehow you're more moral, more righteous than someone who is in debt. I hope discussion on this topic starts to expand so that there's a more democratic discussion of what the real costs should be ... How are you going to bash a single mother who just lost her job and is trying to pay for her kid's medical expenses and pay off her credit card bills and say she deserves to pay 24 percent interest?

I would wager that many people would be shocked to learn about some of the exorbitant rates being charged in low-income neighborhoods by pawnshops, check-cashing outlets, rent-to-own shops, and so on.

In your own fieldwork, you documented the interest rates of these "second-tier" financial services in the typical range of 180 to 391 percent APR, but you note that cash leasing is typically at 730 percent APR and payday loans range from 442 to 988 percent APR. What, if anything, is done about this?

I'm basically involved in trying to affect three pieces of legislation, the College Student Credit Card Protection Act, the Bankruptcy bill, and Predatory Lending issues which relate to these second-tier financial services, where it's very clear that there is bipartisan support.

The industry knows that those rates are not defensible. But they're so lucrative, that they're just trying to figure out how to get a piece of it.

Why would people subject themselves to these kinds of interest rates instead of, for instance, opening a bank account and then obtaining bank loans?

To take one example, there are entire areas of Houston where there are simply no banks, and that's true in other parts of the country as well.

Banks started consolidating and ignoring the Community Reinvestment Act of 1977, which basically said that if a bank takes your money as a depositor, it has an obligation to loan some of the money back to the community. With bank mergers and consolidation, it's hard to figure out how a bank headquartered in Charlotte assumes its responsibility in Central Florida.

When banks left minority urban communities in the late 70s and 80s, white middle class people really didn't care. But now that the banks got away with that, and now that you have these conglomerate bank/financial services like Citibank, they're going to start abandoning lower-middle class neighborhoods. If you're talking about a neighborhood where the median income is $35,000, they're not going to be buying new cars every two years, and they'll buy a maximum of one or two houses, and they're not going to be buying annuities for a pension or investment services or insurance services ... it's just a matter of time until the Citibank branch gets pulled out and gets replaced with First Capital Associates, which is a predatory lender.

The next question is are they going to be bold enough to turn their backs on white, lower and middle class communities?

And you think they are?

I think they are.

Can you explain what cash-leasing and payday loans are?

That's when you take anything of value -- a refrigerator, for instance -- and bring it in and sell it for $300, and then you lease it back at 30 percent interest per month. One of outcomes of financial deregulation is that it has redefined what a loan is so that usurious rates can be charged. Cash leasing emerges so that they can charge 30 percent interest for a 15-day loan. Because they can say that they're not making a loan, they're simply leasing the money.

Payday loans are the fastest growing component of second-tier financial services. Essentially, you're postdating a check at anywhere from 15-40 percent per two week loan. What's extraordinary about the second-tier financial services is that as long as it was poor people, nobody really cared. But now you're seeing more middle class that are heavily in debt ... we're now seeing second tier financial services becoming a normal part of the suburban landscape.

And that's also manifested in the form of these "refund anticipation loans," issued at H&R Block and so on?

Yes ... If there's a way to charge usurious interest, they do it. What's astounding is that the states haven't successfully fought it.

What does the future of the credit card industry look like?

Citibank has a goal of a billion customers by the year 2012, so it's very clear that their future agenda is worldwide expansion. It'll be a tweaking of the very successful marketing campaign in the US, [but] taking place in Europe.

What they did in the US was their proving ground. And as the banking conglomerates have emerged and grown, the only way to sustain that growth is to go after the European middle class ... Citibank knows that there's not much more they're going to get out of the US other than going after college students, and the working poor doesn't take long to tap out. Their market penetration is pretty much done. So that's why for the future -- to keep these double-digit growth rates -- they've got to get much more aggressive overseas.

Citibank is already starting to break away from Visa, and they're not going to keep paying all the fees of belonging to the association ... There's this whole myth that underlies the argument of the industry that there [are] over 6,000 issuers [of credit cards]. Most of the issuers are actually owned by the top ten credit card companies. There [are] a lot of very good reasons to file antitrust suits, but this administration isn't going to pursue them.