The Credit Industry - Death of the Pie

Phil Harris
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Posted: Sep 20, 2008 12:01 AM
The Credit Industry - Death of the Pie

If we examine the current state of affairs in the credit industry through the lens of common sense, it is not difficult to overcome the insane tendency to ascribe Solomonesque wisdom where it doesn’t belong. The simple truth is that the credit and banking industry has been in the process of grooming itself for collapse for many years, particularly in the handling of private consumers.

No matter how brilliant you believe the gurus and CEO’s may be, they have clearly been myopically focused on the economic pie and how to divvy it up for the benefit of their respective interests, institutional and personal. The trouble with this tunnel view is that it ignores the foundation on which the pie is built.

The pie pan (the consumer) makes the pie possible. When the pie pan is allowed to rust through, the pie will pour out and a gooey mess is left behind. Myopic know-it-alls will stand looking down from on high, seeing the deflated pie crust, and believing that a pie continues to exist. In fact it is now an empty shell.

This begs the question, who is to blame for the rusted out pie pan? A standard retort from the “all is well” crowd is that irresponsible borrowers are the culprits. Unfortunately, this snappy (condescending) attitude fails to recognize that the “all is well” crowd could not even begin to form the pie pan on which their own stable economy depends.

People come in many shapes and sizes; widely varying income generating abilities, life changing circumstances and events, and regional employment opportunities and constraints. The collection of regular folks that possess a meaningful disposable income after living accommodations and transportation requirements are paid, is relatively small.

It does not take much of a disruption, such as a period of unemployment or unexpected and unavoidable expenses to knock hard working families on their tailbones. This is where the phenomenon of institutional greed meets the pie pan, when corrosion begins to eat at the very foundation of the economic pie.

Take a typical working family that has been tooling along, enjoying what most would recognize as the average American lifestyle. The family depends on two incomes, not atypical in today’s reality. Each working member needs transportation, and the traditional expectation in American is to purchase a home.

Gone are the days when a modest home could be purchased for less than twenty-thousand dollars; a sum that will barely construct a garage today. In fact, gone are the days when an older home can be purchased for less than eighty-thousand, as was the case for us in the 1980’s. Those homes are now $120,000 and up.

In any case, the combined family income is modest. The median household income around here, for a family of three is about $59,000. Of course, that being the median should give us a clue that there are quite a number of households that enjoy far less than the median.

Common sense, as opposed to some hollow mantra about making responsible financial decisions, will suggest that people are going to do their level best to provide as much “normal” as possible for their families. This means that millions of below-median-income folks are going to reasonably expect to buy homes and reliable transportation that allows them to maintain (at least) their below-median incomes.

This common sense reality also means that millions of regular folks are going to be at the edge of sustainability. They will be on the proverbial one-paycheck from disaster boat, and they will be there without making foolish, extravagant, frivolous credit decisions. They will simply be living up to the basic American expectation.

These regular folks have managed to qualify for credit to sustain their modest living circumstances. They also know that credit cards are made available for a purpose, to fill in those gaps that pop up occasionally in the budget. Gaps like needing to replace the refrigerator that died during the night. No doubt, there are plenty of excesses in credit card use, but often times these accounts are used for less than frivolous purposes.

Things can and do go temporarily awry. The loss of a job or perhaps, the five-year old minivan has suffered a transmission failure. To maintain employment the transmission must be fixed and the budget goes bust; something is going to be late.

The obvious solution to this problem, from the creditor’s perspective, is to punish the irresponsible late-payment maker with stratospheric fees and penalties. Late payment fees often push the balance beyond credit limits, triggering over-limit fees. The combined effect of this “punishment” often pushes the amount needed to stop the cascading disaster beyond the ability of struggling families to pay. Not without sacrificing another element of their payment obligations.

Once this has occurred, interest rates on cards are automatically jacked up to ridiculous levels, above 30% in many cases. Credit scores can be damaged in a short time while people struggle to regain control. This in turn affects their ability to restructure other debt such as mortgages.

Many well-intentioned families purchased homes using adjustable rates, because such loans made it possible for them to do so. After three years, they expected to refinance more favorably, and such did not seem so unreasonable. In the interim, if there has been a disruption and credit scores suffered, refinance options become limited or worse, impossible.

Can you see the unraveling? There is no rocket science involved here. A very large segment of the American economy; regular folks with below-median incomes have been ravaged. Their purchases are an integral and sustaining factor in holding the economic pie together. They are the bulk of the pie pan, yet they are treated like misbehaving children who must be spanked.

The credit industry, in a fit of greed, recognized that an enormous profit center existed in high penalties and fees. They justified these as necessary for making credit available, but this has proven to be false. Instead, these actions provided profits in the short term, while setting up a disaster for the economy down the road.

They also recognized an opportunity to jack interest rates beyond reasonable on existing credit balances held by people who have no choice but to pay them. Similarly, adjustable rate mortgages were not structured to increase by reasonable increments, but instantly jump by several percentage points, creating payments that have nothing to do with a family’s ability to pay them.

Of course, the “all-is-well” segment, those who enjoy dual incomes each well beyond the median-income of families are quick to assign the charge of irresponsibility to their lowly brethren. The short-sighted ignorance of this attitude makes them incapable of seeing the pie pan for the fruity delights they believe are their due. In truth, were it not for the millions of below-median income families who earn what they can and spend what they must, the “all-is-well” folks would be hard pressed to sustain the desserts they have grown to expect.

Certainly, this will sound like so much class-envy to many, but such could not be further from the truth. The upper-middle class seems to have no comprehension that the lower-middle class makes life good for all. An expectation that those on the mid to lower end of the spectrum must be satisfied to live in noisy, crowded apartment complexes, and drive smoke-blowing, on-the-brink heaps to jobs, is incredibly moronic.

People willing to work, should have an opportunity in this country for an American lifestyle. Not a guarantee of luxury, and certainly not a sense of entitlement, but a reasonable expectation that a stable home can be obtained and maintained on the basis of hard work and realistic expectations. If our economy is incapable of sustaining this for the regular folks, then it is not structured in a way that is sustainable.

When “Bob” suffers a heart attack, I don’t think that a prudent EMT would decide that the best way to keep “Bob” going is to make him do a hundred pushups. A family that is experiencing a financial crisis and temporarily cannot honor their credit obligations is no different. Just as the cardiac patient would likely die if subjected to some kind of punishment for becoming ill, why would one expect anything different when a family’s finances become sick?

This is the corrosion that has eaten away the pan holding our economic pie. Condescension from the lofty amongst us will only ensure that the pie drains into the fire. Such has been the attitude from the top and this myopic, greed-driven attitude has nearly killed the pie, and has placed the credit goliaths on a road to self destruction. Surely, we can dream up a plan that helps struggling families return to stable financial health, allowing them to honor their reasonable obligations, and saves the life of the pie for the sake of all.