The following is a guest post from Jay Weiser, associate professor of law at Baruch College’s Zicklin School of Business.
Even as critics on the right and left unite against crony capitalism, crony consumerism continues to enjoy widespread support. Two recent articles decrying predatory practices in the financing of consumer durables illustrate the point. “USA Discounters hooks some service members with credit before springing the debt trap,” by Paul Kiel of ProPublica, and “In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates, by Jessica Silver-Greenberg and Michael Corkery of Dealbook, both paint a picture of nefarious businesspeople (who make The Simpsons’ Mr. Burns look like a choirboy) pushing unaffordable credit on dewy-eyed, innocent consumers. This three-hankie narrative more closely resembles a three-card monte game that distracts viewers from what’s going on underneath.
Wide availability of credit encourages some consumers to overextend, default, and go bankrupt. While Silver-Greenberg and Corkery‘s used car article asserts that fees and high interest rates on subprime used car loans have “generated rich profits for the lenders and those who buy the debt,” firms serving these consumers typically do not make extraordinarily high profits given the high default rates. In his Washington Post piece, ProPublica’s Paul Kiel claims that retailer USA Discounters loads up young servicemembers on overpriced computers and home appliances, hits them with high default interest rates, sues them in a Virginia court remote from where many are based, garnishes their wages, and leaves them at the edge of destitution.
Both articles minimize the consumer role. Silver-Greenberg and Corkery accept at face value borrowers’ claims that they didn’t collude with the loan originators to falsify their income — though one borrower noted that living in the suburbs, “I just can’t get around without my car,” even if he couldn’t afford one (a telling example of how U.S. low density land use policies entrench poverty).
Kiel’s servicemember interviewees lacked good enough credit to buy from national retailers (even though firms such as Walmart and Amazon offer inexpensive credit to qualified buyers), a problem exacerbated by federal paternalism. Concerned with possible financial ruin for active-duty servicemembers with debt obligations stateside, Congress passed the Servicemembers Civil Relief Act, which is essentially an unfunded mandate on creditors. The SCRA limits interest on active-duty servicemember debts to 6 percent, below market for most consumer debt, and restricts enforcement actions. USA Discounters’ seemingly high prices are actually a finance charge and credit insurance in disguise, raising prices for all customers to cover the anticipated losses from active-duty customers. Similarly, while Kiel criticizes the company’s practice of requiring all litigation to take place in its Virginia home jurisdiction, regardless of the servicemember’s location, he produces no evidence that USA Discounters is collecting unowed debts. He fails to credit USA Discounters’ argument that, by centralizing collection lawsuits, they can collect more cheaply and thus pass on the savings to their non-defaulting customers.
Both articles are consistent with crony consumerist ideology, which implies that lenders should make cheap credit available regardless of ability to repay. (The federal government, not content with its housing “affordability” push of the Clinton and George W. Bush years, has recently arm-twisted credit agencies to manipulate credit scores upward). If lenders don’t comply, they are sued for discrimination based on racially disparate impact. If they do, they will be attacked for predatory lending or unfair collection practices. Louis Hyman’s book Debtor Nation shows the same forces operating nearly a half-century ago, and post-2008, home mortgage documentation litigation has allowed many defaulted borrowers to remain in their homes free of charge. In crony consumerist ideology, debt is a euphemism for a cash advance with repayment optional — a gift, in layman’s terms. Unfortunately, there is no free lunch: if lenders can’t collect from deadbeats, they have to raise prices for everyone else to cover the losses.
Kiel identifies a real problem with youthful servicemembers, many in their first real jobs, who fail to understand the risks of installment debt. The work of leading financial literacy scholar Annamaria Lusardi provides little comfort: most people, particularly in the servicemembers’ demographic, don’t comprehend even the basics about interest, and studies suggest that financial literacy education has little long-term effect. Given that the military already offers free financial counseling, perhaps it should require mandatory just-in-time counseling before servicemembers enter into financing arrangements involving payroll deduction – and sharply limit the percentage of income subject to payroll deductions.
Incentives are best aligned when the market, rather than politics, allocates risks between borrowers and lenders. Paternalistic efforts to discourage imprudent borrowing will choke off some bad loans while redirecting part of the credit flow into higher-cost channels such as loan sharking. Honest policymaking chooses among the tradeoffs.