Well hooray! Ten US banks have been given permission to repay their TARP loans from the federal government – $68 billion worth. This governmental Seal of Approval may mean these banks are healthy and safe and ready to do business, but what it certainly means is that the executives running these banks want to escape any government control over how much they pay themselves.
What’s in it for us the taxpayers? Not much. The government still needs to borrow trillions and trillions of dollars, which means interest rates aren’t going down. No fundamental reforms have been imposed on the banking industry ”“ just some tweaking around credit card rules ”“ so you still will have a very hard time getting credit. You’ll also earn about 0% interest on your bank deposits, but pay 30% or more for credit depending on your financial condition. This is certainly not going to get the consumer spending or the economy moving, so what is it going to take to enact real change to our financial system?
Our own Zuma has come across a potent set of proposals for real reform from the author William Greider. You’ll want to check out both Zuma’s report on the Diaries page, as well as Greider’s article on Alternet (printed originally in The Nation). The gist of these reforms is radical in today’s political climate ”“ it is nothing less than a legal cap on interest rates. No bank or finance company would be able to charge you more than this cap ”“ to do otherwise would be considered usury. What would our economy look like if we had laws against usury?
Why Interest Rate Caps Were Abolished
That’s actually not too hard to answer. The US did have usury laws for a long time up until 1980 when they were completely abolished ”“ by Democrats. The problem was the usury caps were becoming outmoded in the face of sky-high interest rates imposed to fight double-digit inflation. It was not just that the banking industry wanted to get rid of the usury laws; when the Fed was setting the base rate at 11%, and mortgage rates were at 18%, a usury cap of 15% made no sense.
Very quickly, though, some financial instruments began to carry unusually high interest rates, like credit cards, which throughout the 1980s had a peak rate of around 22%. The public was ”œoutraged” at a rate that used to be associated with loan sharks, but the banks pointed out that losses on credit cards in the 1980 ”“ 1982 recession were unexpectedly high and justified such high charges for poor credit risks. Once Ronald Reagan came to power, there was no going back. Free market orthodoxy now ruled the day and the market was allowed to charged whatever it wanted.
Not surprisingly, borrowing rates inched up as the years went by. The credit card industry discovered it could get away with charging 30% – 35%, as long as it stratified card users into risk categories so that middle class and wealthy customers would be charged a more tolerable 15%. These lucky customers, however, rarely borrowed on their credit cards. It was the lower middle class credit user who needed to run a monthly balance, so the preponderance of Americans with such balances were poor credit risks paying 30% or higher.
Growth of the Debt Trap
As we entered the 1990s, something else began to happen to the consumer. Their wages were stagnating, eaten up by rising medical and other costs, so consumers had to borrow to maintain the basics of life such as food and shelter. The credit-worthiness of consumers gradually deteriorated under these conditions, and by the time George Bush wrested the presidency out of Al Gore’s hands, people were borrowing more and paying much more for the privilege.
William Greider writes about the implications of borrowing at excessive interest rates.
Usury is the ancient sin of charging inflated interest rates sure to ruin the borrowers. It is considered immoral by Judaism, Christianity and Islam because usury involves the powerful using their wealth to ensnare weak and defenseless borrowers. The classic usurer offers an impossible choice that debtors cannot easily refuse. If they reject the terms of the loan, they will not be able to pay the rent or buy necessities. If they accept the usurious interest rates, their debts will accumulate until they are bankrupted (at which point the creditors claim their property). No civilized society can endure in such conditions.
The impossible choice referred to here occurs when a consumer needs to borrow for necessities, but the interest rate is high enough that interest on the debt keeps mounting, making it impossible to repay the debt in full. This is known as a debt trap. Exactly what that rate of interest might be depends on the economic condition of the consumer (particularly whether they have any savings to use as collateral), the minimum repayment required monthly by the bank on its loans, and the general level of interest rates in the economy. This makes it hard to say what interest rate might constitute usury at any particular time, though we can say even wealthy people would have trouble retiring a debt where the interest rate is in excess of 30%.
Another way to gauge whether interest rates are usurious is to keep track of how many consumers are in a debt trap. Are they borrowing on their credit cards to pay for basic necessities? Are they borrowing from one source to make minimum payments to another creditor? Is their cumulative debt rising rather than being paid down? There is no doubt that millions of Americans were in this situation by 2000. They were already debt slaves, and usurious rates were clearly at work in the market.
The poorest of the poor couldn’t even borrow at 30%. They were forced to rely on payday loans, using their paycheck at a currency exchange to take down a loan that had equivalent annual interest rates of 400% or higher. If the loan couldn’t be paid in full when due in two weeks, the next paycheck was used to roll it over, and suddenly the consumer was snared in a debt trap of ferocious persistence given the interest rates charged.
At Last, a Proposal to Abolish the Debt Trap
Greider mentions several community activists and community groups who are pushing for usury caps. The caps range from as low as 9% to as high as 30%. These caps would make it much more difficult for consumers to fall into debt traps, which means the consumer would have a reasonable chance to pay down their debts over time. This would also set the banking industry back to the profitability levels of the 1970s when such caps last existed. There is simply no way the banking industry is going to readily accept such a drastic reduction in its income, and such a major change in its business practices.
It is this latter point that is critically important to understanding the debt trap. Banks in the past 30 years have abandoned their traditional fear of lending to consumers, in part because they can charge unlimited interest rates to cover whatever they perceive to be the risk involved. Banking behavior has therefore changed from avoiding certain consumer loans, to encouraging almost all types of consumer loans.
Offers for credit cards have flooded consumer mailboxes almost daily, at least until the this credit crisis hit, and even today consumers who make their monthly credit card payments are sent blank checks in the mail, urging them to borrow sometimes tens of thousands of dollars. It used to be that the debt habit, rather like the smoking habit, started in college when students were offered their first free credit card; now grade school children are being enticed into the borrowing habit. The universal FICO score used to assess a consumer’s creditworthiness actually penalizes people who do not borrow at least some amount of money.
These days, a ”œdeadbeat” is someone who pays all of their bills on time, never borrows, and therefore deprives the banking industry of interest income. To get even with these people, and to disguise the usurious interest rates being charged, banks have invented a host of ”œfees” that penalize consumers for the slightest failure to meet the tiny print rules associated with their credit card, auto, mortgage, or home equity loans. These rules no longer allow a three or four week period to pay your monthly bill; now the bill is due in two weeks or less. Often it is due on a Saturday or Sunday, causing a late payment fee of $30 or higher.
The large banks derive over half of their net income these days from fees, not from interest revenue. The business of generating fees ”“ and it is a business ”“ has gotten nearly diabolical. It used to be that your checking account would record your debits and credits in the order in which they were received, and checks drawn on other banks could take two or three days to be processed through the clearing house. Since most checking accounts now have debit or ATM cards attached, big banks have deliberately changed these rules. Now all of your debits are processed instantly, the largest going first. Your credits ”“ even if you transfer money from an account within the same bank ”“ are delayed at least a day.
The diabolical aspect of these changes is that the process almost assures a consumer will have a negative balance at some point. But rather than reject the next debit at the retail outlet or gas pump, the banks allow it to go through, creating a deliberate overdraft. Conveniently ”“ for the banks ”“ the checking account has had attached to it an overdraft borrowing account that was never asked for by the consumer, and cannot be opted out. It just shows up one day buried in the fine print updates that banks send out frequently and which are impossible to read or understand.
Millions of Americans have discovered that their debit card has gone overdrawn for $5, and a $35 overdraft fee has been applied. They are now $40 in the hole, and this amount starts compounding every day it is not rectified, with additional $35 charges. It is not uncommon for the card holder to rack up hundreds of dollars in fees and overdraft charges each year on an account that rarely has more than $100 processed each month. The inherent interest rate in these fees and charges is beyond usurious ”“ it comes to 1,000% or more, and it has become a serious cash drain on poor people, worse than their payday loans.
It is not enough, therefore, to impose usury caps on interest rates ”“ the whole definition of what constitutes usury needs to change to incorporate the dozens of fees and charges that plague checking and savings accounts. In other words, the reform has to come to the very way banks do business, because the fees and charges for overdrafts and NSF checks are a business. We should make no mistake about that. There are executives responsible for devising these processes, they have revenue targets to meet, and they have to do all this at the balancing point where the average consumer is irritated but not so annoyed that they will complain to Congress.
No More Loan Sales or Securitizations Either
So far, the reform efforts that Greider is describing only concentrate on simple fixes like a cap on interest rates, though community groups are well aware of the gouging and sub tabula usury rates that are being charged in the overdraft business. It is felt, though, that it will be hard enough to get Congress to look even at simple usury caps. The Democratic leadership in Congress has refused to let such bills come before the House or the Senate, though Vermont Senator Bernie Sanders did recently force a vote on a proposed usury cap at 15% that was defeated 60-33.
The Democrats who lined up to vote against this bill tend to sit on the finance committees in Congress, and derive considerable campaign donations from the banking industry. They are much more prone to listen to banking executives than they are to consumer advocates. Nor is there any pressure for change coming from the White House. The Obama administration seems every bit as beholden to and, you might say smitten by, the views of the bankers.
What the bankers are saying is that usury caps won’t work. Too many people with poor credit will be deprived of credit altogether if usury caps are imposed. This argument is correct. If the banks suddenly had to look at the true repaying capacity of the consumers receiving credit, they would cut off millions from the credit spigot. In fact, that is happening throughout this credit crisis, as credit cards are being withdrawn and home equity lines of credit canceled. The banks have discovered that putting consumers into a debt trap might have worked in the past, but in a recessionary environment it just hastens the day when the consumer collapses and defaults altogether.
This does not mean that the banks have given up on the debt trap business. They are merely recalibrating the pressure points of the trap itself, so that in bad times the consumer will still be able to service the debt even if their income declines. What the reform groups want is entirely different; they want banks to get out of this business completely. They want to return to the 1970s, to a time before the Reagan revolution that brought us into mindless worship of the markets as all-wise and all-powerful. They are even proposing that banks be denied the ability to sell a consumer loan or securitize it to investors. Once a bank makes a loan, it will be required to hold on to it until maturity, thereby taking full responsibility for any losses on its own books rather than passing such risks off to other banks or investors.
The reform groups see, correctly, that the sale or securitization of a loan destroys the need for credit checks and analysis, so that no one in the process really cares whether the consumer could pay back their debt. Most observers, even the banks, agree that the securitization process was flawed precisely for this reason, but the only proposal out there to fix this problem comes from the reform groups that want to outlaw loan sales and securitizations entirely. The banks have not come up with any other ideas because, for the moment, the securitization process is dead. Even though the federal government has stepped in to guarantee securitizations, the market has not revived, which tells us that there may be no way to solve the lack of credit analysis when a loan is securitized or sold.
As of now, the amount of credit flowing through the US economy is near the levels last seen in the early 1990s. In some markets and instruments, credit simply doesn’t exist, so we are back to the early 1980s before the Reagan boom began. If Congress did pass usury caps and outlawed loan sales and securitizations, it would ensure that the US would operate on a flow of credit that was much reduced from the peak years of 2005-2007, and that was more suitable for an economy twenty or more years ago. It is no wonder even the Democrats balk at such a decision.
The Social Cost of Eliminating the Debt Trap
There is another factor to consider here as well. Suppose a usury cap is put in place and millions of poor people are now denied payday loans or their equivalent through ATM debit cards. How will they feed their family or pay the rent? This is a very serious question that is now starting to affect middle class consumers as well. Too many people are completely dependent on credit for the basics of life, and the debt trap is the only avenue they have to maintain even a parlous existence.
It used to be such people had government programs like welfare and food stamps to rely on in tough times, along with unemployment insurance and union payments to laid off workers. The social safety net was virtually dismantled in the 1990s under Bill Clinton, and of course union membership is a small fraction of what it was in the 1970s. In eliminating the social safety net, the theory was that the market would take care of such problems. If people were responsible for their own well-being in times of stress, they would take greater care to save money. Unfortunately, it has proven almost impossible for most middle or lower class people to save money. What has been proven true, though, is that the market did deal with the problem, in a perverse way. The banking industry has become the country’s social safety net, by providing credit even to the poorest of the poor.
The policy conundrum we face, therefore, is how to dismantle the debt trap and the egregious practices of the banks, yet provide for the millions of Americans who use debt for survival. Proposals to bring back usury caps and eliminate loan sales and securitizations are well and good, but they will do more harm than expected if the social safety net isn’t restored first. There is little incentive for Congress or President Obama to pursue true banking industry reform, mostly because the banks own the Congress and were the biggest contributors to Obama’s campaign. And there is even less talk about restoring welfare, improving unemployment benefits, or expanding the food stamp program, beyond superficial changes.
In the meantime, the banking industry is holding on to its usurious lending practices. It has to because the amount of income derived from these practices is too large to forego. But these practices are already under stress, as banks have had to narrow the field of prospective customers in this recession. And now they are under attack from outside through the community reform efforts.
You therefore have two forces, one internal and one external, pushing the banking industry towards fundamental reform, ultimately leading to an abandonment of the debt trap business completely. This would be a very, very good thing for the American consumer, if only the government had some way to provide life’s essentials for the millions of Americans who depend on the debt trap for their survival.
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