Debt and responsibility


in Economics, Law, Politics, Rants

Canada House of Commons ceiling

An article in the New York Times draws further attention to the indebtedness of American consumers: focusing on the degree to which debt is harming the lives of individuals, as well as how the lending practices of firms encourage people to take on more than they can handle. While there is certainly a key regulatory role in preventing fraud and misleading advertising, it is less clear to me that the major fault here lies with companies. As a shareholder in a mortgage company, I might be annoyed that it had chosen to lend to people unable to make the necessary payments. As a member of the general public, it is less clear why I should be excessively concerned – nor why I should have excessive sympathy for those who choose to live beyond their means.

Financial conservatism – the deliberate choice to live below your means and set something aside for the future – is a mindset that is certainly at odds with consumer culture. That being said, it seems sensible for the onus to be on the individual to learn restraint, not for the system to change so that it is no longer required. The lesson that needs to be absorbed is that borrowing is generally only justified in order to invest or to smooth our financial fluctuations. Using it as an unsustainable mechanism for consumption spending will always be a bad choice, no matter what rules various lending organizations adhere to.

Yes, there are unexpected situations that arise and unfairly tax the finances of some individuals. This is one reason for which insurance needs to be equitable and widely available. At the same time, people who have chosen to drive themselves into debt with cars, houses, and consumer products they cannot afford cannot be held entirely innocent when a further financial shock overwhelms their short-term ability to cope financially. That may been like an unsympathetic judgment, but it seems like the only view that incorporates the right incentives.

Another NYT article discusses the compassion versus personal responsibility debate directly.

{ 14 comments… read them below or add one }

ToryC July 25, 2008 at 10:18 am

This is all very true.

One thing consumer protection agencies could do would be to make it clearer to people what various sorts of financing involve. It could be as simple as a bar chart showing the size of payments, off into the future, compared with the sticker price of the object being bought.

Presented with such information, some people will still go the high debt route. That action should have consequences for them and, in the event that they are given too much credit and default, for their overzealous creditors.

Anon July 25, 2008 at 10:53 am

It would also make sense to alter the tax system to encourage saving. Perhaps there could be a reduced rate of income tax for money that gets put into a contingency fund for medical emergencies, unemployment, and the like.

Litty July 25, 2008 at 6:17 pm

Maybe there should also be special protections for young people, like not allowing them to get credit limits in excess of their annual income.

Sarah July 26, 2008 at 2:55 pm

While it is ok in principle to say that people should behave rationally and not take on more debt than they can expect to pay off, people often do not make their decisions according to a rational calculus. As such telling them what a rational calculus would suggest and that they ought to be rational may not have the desired effect. For instance, if renting a house is stigmatised then people may continue to take out mortgages they cannot afford to pay off because it fits with their (and wider society’s) normative framework. Similarly, people take on excessive credit card debt to buy Christmas presents for their kids & are then unable to pay off the cards.
As always, my interest is in finding the policy which successfully produces the desired effect. Expecting individual American consumers to adopt more conservative spending and borrowing habits does not strike me as such as policy, whereas changing the financial regulatory framework & thus behaviour of loan companies may be far more effective.

zoom July 26, 2008 at 6:36 pm

Interesting posts. I have a couple of thoughts on this one.

1. A lot of people don’t ‘get’ finances. The concept of interest, for example, may not be clear to people who are going into debt. How many people buy a house for say $300K one year, sell it for $305K the next year, and think they made a profit? Basic financial education is disturbingly absent from the public education system. It’s time to introduce a contemporary version of Home Economics in schools.

2. The US government sets a mind-boggling example of spending well beyond its means. How much is that war costing again? It’s no wonder so many Americans are confused by economics.

Milan July 28, 2008 at 6:09 pm

It could be as simple as a bar chart showing the size of payments, off into the future, compared with the sticker price of the object being bought.

Data visualization is certainly a powerful way of making things more comprehensible. Something of this sort could have a positive impact.

It would also make sense to alter the tax system to encourage saving.

There are already a good number of incentives (sales taxes, RESP and RRSP plans, etc), but I generally agree. People should have a stronger incentive to save for the future.

Maybe there should also be special protections for young people

This may also make sense, though there are certainly some people in their 20s who are able to use credit to good effect. It is not clear how you could protect the imprudent without cutting off a source of funds for entrepreneurs.

Milan July 28, 2008 at 6:18 pm

Expecting individual American consumers to adopt more conservative spending and borrowing habits does not strike me as such as policy, whereas changing the financial regulatory framework & thus behaviour of loan companies may be far more effective.

The matter is a decidedly complex one. For instance, you might argue that the thing to do is make sure that all lenders know that if they overlend and lose money, they will get no government bailouts. That, in turn, would require keeping them small enough that any number could be allowed to fail.

Another big problem is performance incentives within the financial industry. If you get a guaranteed salary with the possibility of a bonus for high returns, it increases your incentives to take big risks. Many years, you may get no bonus at all. Some years, you will do extremely well. Should government restrict these kinds of practices, or rely on firms realizing that setting incentives geared towards short-term performance will worsen the firm’s performance in the long run?

Another enormous problem is the ideal kind of borrower for most firms. The last thing they want is borrowers who repay loans in timely fashion. They want to be able to spin it out forever, collecting interest and fees. Is there a regulatory approach that would limit this behaviour?

Milan July 28, 2008 at 6:20 pm

A lot of people don’t ‘get’ finances.

True, and problematic.

Better education is certainly part of the answer. So is the obligation for financial institutions to explain things in clearer ways. That said, there will always be people who are willing to pay $2500 for a couch, over the course of the next ten years of credit, than $1000 using real savings today.

The US government sets a mind-boggling example of spending well beyond its means.

True, and problematic.

This administration’s shameful disregard of financial prudence is one of its bigger sins (though there are plenty to choose from). That said, the eventual need to deal with recent excess will be a macro-level reminder of the micro-level consequences of overborrowing.

. August 31, 2008 at 12:54 am
. February 27, 2009 at 5:13 pm

A lament for savers

Feb 12th 2009
From The Economist print edition
Prudence gets penalised

BORROWERS get bailed out. Run your bank into the ground and the taxpayer will lend it money. Buy a house you cannot afford and the central bank will cut interest rates to ease your burden.

Meanwhile those who have lived within their means and put money aside for the proverbial rainy day, have seen interest rates slashed to 2% in the euro zone, 1% in Britain and virtually nothing in America. No one offers to help them out, even though saving is needed to allow business investment which, in turn, generates growth. Asians, told off in the 1990s for their current-account deficits, now get lectured for saving too much.

Of course, politicians and economists will argue that they are only talking about the short run. They need people to spend to lift the economy out of recession. As John Maynard Keynes remarked: “Whenever you save five shillings, you put a man out of work for the day.”

R.K. February 27, 2009 at 5:40 pm

The solution to the problem raised in the Buttonwood column is to save in secret. If the government knows about your reserves, they will not help you. At the same time, having reserves means you aren’t out in the cold if the government cannot help you.

Swiss banks, anyone?

. March 12, 2009 at 2:59 pm

Barack Obama’s budget
Wishful, and dangerous, thinking

Mar 5th 2009
From The Economist print edition
The president has not explained to Americans that if they want bigger government, they will have to pay for it

” Although Mr Obama’s revenue plans are not clad in the ambitious rhetoric of his spending initiatives, they are just as profound. To pay for his plans and get the deficit down to manageable levels, he would return top tax rates to where they were before George Bush cut them, extract more from the rich by capping their deductions, increase taxes on corporations and auction carbon-emission permits. At the same time, he promises permanent tax cuts for 95% of workers.

Sadly, these plans are deeply flawed. First, Mr Obama’s budget forecasts that the economy will shrink 1.2% this year then grow by an average of 4% over the following four years. It might if the economy were to follow a conventional path back to full employment. But this is not a conventional recession. The unprecedented damage to household balance sheets could well result in anaemic economic growth for years, significantly undermining the president’s revenue projections. The economic outlook continues to darken and the stockmarket has already tumbled to 12-year lows. Mr Obama may either have to renege on his promise to slash the deficit to 3% of GDP in 2013 from more than 12% now, rein in his spending promises or raise taxes more.”

. October 20, 2009 at 12:29 pm

“Arthur Brooks, the head of the American Enterprise Institute, a conservative think-tank, feels that the real culture war in America today is not about gay marriage or abortion, divisive though those issues are, but about capitalism. Everyone agrees that Wall Street messed up last year, but many are disturbed by the expansion of government that followed the crash. Voters particularly dislike the way the state is using their money to reward deadbeats, says Mr Brooks. They themselves work hard and live within their means. They see their neighbour, who borrowed more than he could afford to buy a fancy house, getting a bail-out to save him from the consequences of his own poor judgment. They see reckless bankers getting bailed out too, and the ill-managed carmakers of Detroit likewise. And they resent it.”

. October 14, 2010 at 2:48 pm

The right way up

SIR – You suggested allowing bankruptcy judges and special trustees to write down balances of loans for homeowners in America who are upside down in their mortgages (“Are we there yet”, September 18th). This ignores the fact that a loan balance represents dollars belonging to someone, either an investor or bank depositor, used to support the purchase of collateral property. Who would absorb the shortfall if this was allowed?

As a banker, I’m sympathetic to those borrowers who are in this upside-down situation. We try to help our customers through these troubled times. But there is a great difference in our attempts to assist these borrowers and any situation which would give them an entitlement to have their loan obligation reduced. There has always been a moral, as well as a financial, obligation to repay loans. If we begin to take steps to set aside that moral obligation, the troubles we see today will pale in significance.

Joe F. Ferguson
Chief executive
Stephens Federal Bank
Toccoa, Georgia

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