Earn What You Spend

In the newest issue of The Atlantic, Virginia Postrel writes an interesting article, The Case For Debt. I was surprised the author could miss the sea of red flags about too much debt at the consumer, corporate, and national level.  But miss it she did, and in fact she tries her best to make the ‘case’ for increased consumer debt.  It’s too bad she conflates cherry-picked anecdotes with a logical argument.  

The byline summarizes the underlying logic of the article: “for many poor Americans, credit cards can still be a better deal than payday loans and pawnshops.”  So, even before the article starts, the flawed logic is evident: credit cards are better than payday loans; therefore debt for consumers is not really a problem. If the baseline for comparison is predatory payday loan shop, then we certainly have a problem. 

Let’s start by breaking down her key points.

1. Debt is as American as Apple Pie, and resurges periodically because it is an evergreen story for the press.
2. Consumer credit is largely used for it’s convenience, “the expansion of consumer credit is one of the great economic achievements of the past century” and consumer credit is “flexible, convenient, impersonal.”
3. Only the wealthy are using this newfound consumer credit, and “if the rich are getting richer, it makes sense that they’re also running up more debt. They can reasonably expect to pay it.”
4. Credit card fees have come down.

The conclusion for Postrel is rather simple: we’ve always had debt, and we aren’t currently facing a crisis in consumer credit. Let’s look at her four points one by one, in reverse order.

4.  Credit card fees have come down.

While true, this point is simply a non sequitur. Credit has become cheaper, easier to access, and more readily available to people from all economic backgrounds.  But that tells us nothing about the overleveraged consumer; rather, it is simply a reflection of the reality of the regulatory environment.

The credit card industry has a notoriously powerful lobbying arm, and this can clearly be seen in the updated bankruptcy laws that went into effect in 2005.  Chapter 7 bankruptcies became much more difficult to file.  Not surprisingly, 

Consumer advocates argue that the new law is a gift to creditors – particularly the credit card industry, which may receive $1 billion or more from repayment plans due to the expected increase in Chapter 13 filings.

So while consumer credit has certainly become more readily accessible, so too have bankruptcies.  And now this easy, low-cost credit follows the consumer beyond their bankruptcy. 

3.  Only the wealthy are using this new credit, and they can afford it. 

Can they?  These wealthy also have a significant percentage of their assets tied up in the stock market, and that clearly hasn’t done so well over the past year.  (Or Decade, for that matter)

The Detroit Free Press has an excellent article on the state of debt in our nation, and I’ll quote from it a few times in this post.  One bankruptcy lawyer states

“I’m seeing a different kind of client now than I’ve seen before. It’s hitting the upper middle class,” she says. One client, a real estate professional, saw his annual earnings drop from more than $200,000 a couple of years ago to less than $15,000 today, Howard says.

Further, which class of the wealthy is Postrel speaking of?  As Richistan points out quite well, income inequality is at unprecedented levels in our nation.  Her example of Cindy McCain’s Amex bill is so far removed from the average consumer it is almost laughable. 

2.  Consumer credit is convenient

This is undoubtedly true, though the terminology here is quite misleading.  Carrying cash around is a pain.  I’m an avid user of tracking software such as Mint, which is significantly easier to use in conjunction with your credit card. 

But here Postrel is conflating the use of a credit card as a charge card versus the revolving credit of a credit card.  There is no loan per se in a charge card, and usually no set interest rate.  You pay the balance in full, and are awarded this convenience thanks to an annual fee.  American Express has long understood this distinction, and Postrel’s example of Cindy McCain is nothing more than a sleight-of-hand to conflate the convenience of a charge card with the actual revolving credit of a credit card. 

Now, it is true that most credit cards are simple to use in the manner of a charge card (just pay off your balance each month), but a missed payment will quickly teach the consumer this important distinction. 

If Postrel wants to make the case for debt, she should should do so with an example that actually pertain to consumer credit.  A charge card is hardly a telling example of the potential benefits of leverage. 

1.  Debt is as American as Apple Pie.

This is true.  But again, this does not mean all is well in the land of consumer credit, and it absolutely does not make the case for debt.  Take a look:

Source: Detroit Free Press

First, in making the case for debt, Postrel conveniently write only about credit cards. Consumer credit goes well beyond that, and any student of the current crisis knows that its roots lie in home mortgages, that other (formerly) easy source of credit.  Again, according to the Detroit Free Press, 

• The average household now holds more than $110,000 in mortgage and other debt…

• American consumers today collectively owe $2.5 trillion on their credit cards and in car payments and similar loans. That’s up 150% from 1994, an increase more than four times greater than inflation over the same time.

• New college graduates carry more student-loan debt than ever. The nonprofit Project on Student Debt reports that by the time they graduate, nearly two-thirds of students at four-year colleges and universities have student loan debt, compared with less than one-half of graduating students in 1993. Over the past decade, debt levels for graduating seniors with student loans more than doubled from $9,250 to $19,200 — a 108% increase, or 58% after accounting for inflation — the project reports.

Credit cards, car loans, student loans, mortgages.  Many of Postrel’s arguments are as applicable to other forms of debt besides credit cards: mortgages had become convenient, their fees had come down, and they were used to finance the lifestyles of the aspirationally wealthy.  Let’s reflect on how well that turned out. 

Consumer debt has exploded while our personal savings rate has plummeted.  We save less and less, but spend more.  How?  We finance it.  Just look at our savings rates:

Source: St. Louis Fed

Conclusion: 

There are plenty of valid cases to be made for consumer credit and debt; if Postrel had written about why it makes financial sense to use a mortgage to buy a house, about amortizing costs over long periods of time, that would have been one thing.  But to say that all is well in the land of consumer credit, particularly through the use of misleading examples and irrelevant anecdotes, is bit reckless in a time like this. Credit card delinquencies are on the rise.  Consumers are overleveraged, and the chickens are coming home to roost.  Felix says it best:

Postrel’s right that the media has cried wolf in the past when it comes to consumer credit. But she forgets that in the fable, eventually the cry is for real. Now is that time.