Mike Konczal (aka Rortybomb) has a really fascinating thought experiment over at his blog wherein, a la Star Trek (and later Southpark) he transforms into “Evil Rorty” in order to make a point about the predatory nature of credit cards on the poor, the cognitively weak, and other more disadvantaged types. The point he’s making is basically that the whole “irresponsible borrowers deserve what they get” argument is a false one, and I tend to agree.
The whole process of luring in irresponsible borrowers and then saddling them with fines, fees, and extremely high interest rates strikes me as fairly awful. People with very little credit and fairly poor credit – high risk people like college kids, poor people, and so forth – are nevertheless given high credit limits, are lured in with perks and benefits, and are then pushed into a cycle of debt that is often extraordinarily hard to recover from. Many of these people were high enough risks that responsible lenders should never have extended so much easy credit to them to begin with.
At the very least, already we have two irresponsible parties – the borrowers and the lenders. Both have incentives to get into bed with one another. The borrowers are typically low income or young. Having a line of credit increases their standard of living, at least at first, giving them some financial wiggle room, more purchasing power between paychecks, and a lifeline in case of emergencies. A relatively short line of credit is usually enough for this. A thousand dollars in case the car breaks down or in case you run short on bills and still need to pay for food and gas.
The lender has a more insidious incentive: when the borrower inevitably fails to “act responsibly” the irresponsible lender starts making some real money. That’s why they don’t give out just a thousand dollar credit limit but rather two, three, five thousand dollars – on top of other credit card companies who have already extended similar lines to the same borrower.
People who don’t see a problem with this relationship usually focus on the borrower rather than the lender as the sole irresponsible party, but that’s a wrong-headed way to look at things, especially since many of the people who get into these situations are young, ill-informed, and not prosperous or wise enough yet to manage the sort of responsibility that comes with having credit. In America, this sort of borrower is considered fair game, and the people who lend to them are called “bankers”. In more civilized places we refer to these people as “loan sharks”. In civilized places the burden of determining who is a responsible borrower falls on the lender’s head. This is what separates bankers from loan sharks.
This also reminds me of Bastiat’s parable of the broken window. Let me excerpt a bit of that here. Imagine the window in question is actually an unsustainable credit card debt and the expense of fixing the window is the expense of paying all the fines and interest on that debt:
Have you ever been witness to the fury of that solid citizen, James Goodfellow, when his incorrigible son has happened to break a pane of glass? If you have been present at this spectacle, certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: “It’s an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?”
Now, this formula of condolence contains a whole theory that it is a good idea for us to expose, flagrante delicto, in this very simple case, since it is exactly the same as that which, unfortunately, underlies most of our economic institutions.
Suppose that it will cost six francs to repair the damage. If you mean that the accident gives six francs’ worth of encouragement to the aforesaid industry, I agree. I do not contest it in any way; your reasoning is correct. The glazier will come, do his job, receive six francs, congratulate himself, and bless in his heart the careless child. That is what is seen.
But if, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.
It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.
Let us next consider industry in general. The window having been broken, the glass industry gets six francs’ worth of encouragement; that is what is seen.
If the window had not been broken, the shoe industry (or some other) would have received six francs’ worth of encouragement; that is what is not seen.
And if we were to take into consideration what is not seen, because it is a negative factor, as well as what is seen, because it is a positive factor, we should understand that there is no benefit to industry in general or to national employment as a whole, whether windows are broken or not broken.
Now let us consider James Goodfellow.
On the first hypothesis, that of the broken window, he spends six francs and has, neither more nor less than before, the enjoyment of one window.
On the second, that in which the accident did not happen, he would have spent six francs for new shoes and would have had the enjoyment of a pair of shoes as well as of a window.
Now, if James Goodfellow is part of society, we must conclude that society, considering its labors and its enjoyments, has lost the value of the broken window.
From which, by generalizing, we arrive at this unexpected conclusion: “Society loses the value of objects unnecessarily destroyed,” and at this aphorism, which will make the hair of the protectionists stand on end: “To break, to destroy, to dissipate is not to encourage national employment,” or more briefly: “Destruction is not profitable.”
And that’s the thing about irresponsible lending and the various predatory techniques which Evil Rorty exposes so well. Rather than acting as an economic benefit (which a short line of credit for low-income people certainly could act as), this sort of lending actually operates as a form of intentional destruction. Like Bastiat’s window, it forces consumers to spend money on one thing (fixing their debt) when they could have been spending it on something else (like a new pair of shoes). This works to one industry’s gain – the financial industry – at the rest of industry’s loss. And it is a negative gain for the economy, because these fines and absurdly high interest rates don’t actually produce anything. It is money taken out of the economy for, essentially, purposefully broken panes of glass.
So before anyone starts blaming the irresponsible borrowers and praising the responsible ones, I think we need to remember the other irresponsible party here – the lenders – and their blatant effort to transfer wealth out of the rest of the economy and into their pockets by preying on high risk customers who they can be relatively certain will fall behind on payments and into a spiral of fines, fees, and perpetual debt.
Now perhaps there is a reasonable free market solution to this mess. I’m sure there are some very compelling libertarian arguments as to how the credit card industry has been nudged into this situation in the first place by poor regulation and how a freer credit landscape would solve all these problems. I’m sure it would – if we were starting from scratch and could have the foresight and wisdom to erect a better credit card marketplace. But we’re not starting from scratch.
So instead of just proposing deregulation of credit card markets, we need a reasonable road map to get away from the current system and toward one that functions to the benefit of the economy as a whole. This is a fine line, I think. Severely restricted credit can have its own drawbacks. But I think somewhere between the free market camp and the better regulation camp lies a reasonable solution, where credit can still make it to poor and working families, but in amounts that won’t spiral them into debt and with penalties that are less destructive and more practical and appropriate. Maybe this requires drawing down some of the regulations which force out competition, but I think it also requires rules that make the relationship between lender and borrower more transparent. And it probably also requires some way to make bankers start acting like bankers again, which will require a shift in the incentive structure currently in place.