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.
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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.
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.
Maybe there should also be special protections for young people, like not allowing them to get credit limits in excess of their annual income.
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.
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.
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.
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?
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.
PBS series:
frontline - secret history of the credit card