Accountable Strategies blog

A blog about accountability issues in the public, private, and nonprofit sectors

Saving us from the credit industry

Posted by David Kassel on May 5, 2008

There has been a lot of discussion lately about the need for more regulation of hedge funds and investment banks to prevent another credit crisis from even further damaging the U.S. economy.

But what about another, potentially even darker side of the credit industry–those unscrupulous mortgage, credit card, and other lenders who are slowly drowing the middle class in America in a sea of unpayable debt?  In Making Credit Safer, Elizabeth Warren makes a persuasive case that more regulation is desperately needed in that arena as well.

Warren, a Harvard Law School professor, notes that it is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house.  But it is possible to refinance your home with a mortgage that has the same one-in-five chance of putting your family out on the street.

In addition, while it is impossible for the seller to change the price on the toaster once you’ve bought it, your credit-card company can triple the price on the credit card you used to finance your purchase, even if you meet all the credit terms.  Products sold in America are regulated by the Consumer Product Safety Commission, but credit products “are regulated by a tattered patchwork of federal and state laws that have failed to adapt to changing markets,”  Warren writes.

Americans turned over $89 billion in fees, interest payments, added costs on purchases and other charges associated with their credit cards.  As Warren notes, that’s $89 billion that didn’t go to new cars, new shoes, or any other goods and services.  And not all of these costs are measured in dollars.  There is also the anxiety and shame that accompany Americans struggling with debt.

Warren makes the case that foolishness and profligacy on the part of those in debt doesn’t explain the entire problem.  Lenders, she notes, “have deliberately built tricks and traps into some credit products so they can ensnare families in a cycle of high-cost debt.”  Credit card interest rates often hover around 30 percent, while so-called Payday loans can have interest rates of nearly 500 percent.

The average credit card contract has become an incomprehensible morass of clauses that culminate, in one case, in the statement by one prominent credit card company that, “We reserve the right to change the terms at any time for any reason.”  Then there are the “yield service premiums” or YSPs that mortgage companies pay to brokers who steer families into high-cost, teaser-rate mortgages.  These YSPs helped drive the wild selling, Warren says, that led to the collapse of the subprime mortgage market.

Congress, under the pressure of the mortgage broker industry has done little so far to curb these abuses.  And the traditional state role in regulating credit card interest rates has been usurped by federal legislation that allows lenders with federal bank charters from locating in states such as Delaware and South Dakota that allow them to export uncapped interest rates.

Warren suggests it’s time to create a Financial Product Safety Commission (FPSC), which would be charged with reviewing new credit products for safety and requiring modification of dangerous products.  It would evaluate mortgages, credit cards, car loans and other forms of credit and review such things as unlimited and unexplained fees, inordinately high interest rates increases, and claims by issuers that they can change the terms after money has been borrowed.

Interestingly, the Federal Reserve and other regulatory agencies have just proposed regulations to limit some of the most egregious credit card practices.  Similar prohibitions against excessive fees and interest rates have been proposed in Congress by Sen. Christopher Dodd, D-CT, and Rep. Carolyn Maloney, D-NY.   Hilariously, the banking industry is fighting the move and saying it will hurt consumers.

All of this sounds like a great start, although I wouldn’t get my hopes up that any of it will make more than a small dent in the credit problem in America.  It’s not clear from Warren’s article, for instance, whether she believes the FPSC would have power to do more than evaluate and make recommendations about unscrupulous and dangerous credit practices.  And as she also points out:

Unfortunately, in a world in which the financial-services industry is routinely one of the top three contributors to national political campaigns, the likelihood of quick action to respond to specific problems and to engage in meaningful oversight is vanishingly slim. 

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