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Contents Introduction Understanding Consumer Debt The Merits of Debt? Not One-Size-Fits-All Consumer Welfare & Markets Identifying the Signs of "Bad" Debt Poverty and the Debt Trap The Credit Market & Consumer Decisions to Take on Debt Deregulation and the Democratization of the Credit Market Paved with Good Intentions? The Economic Crisis & Policy Recommendations The Credit Crunch Conclusions & Policy Solutions

The economic crisis has "solved" a couple of problems in the credit market (while assuredly creating other problems). For one thing, loans are no longer so readily being offered to consumers who are likely unable to pay them off. For another, the increase in consumer debt levels, both for mortgages and for other assets, has finally slowed.

But there exist some greater long-term implications. The economy would be paralyzed were the credit market to disappear and consumer spending to further dwindle. A recovery requires some jump in demand. But at the same time, Americans need to be able to start saving again, and a healthy credit market would be a positive investment. For scholars who advocate keeping consumer debt low, there are three general categories of prescriptions for a better future.

Education

A common refrain asks for improved measures for outreach, counseling, and education on behalf of consumers and low-income families in particular. Schools and faith-based organizations, employers and public service providers have some responsibility to better educate the public - especially low-income families - about lending practices before they go into greater debt. If people learn how to better manage their finances and understand loan options there could be a significant public benefit.

Consumption and GDP data from the Bureau of Economic Analysis (BEA). Mortgage equity withdrawals are measured as the year-over-year change in mortgage debt (from the Federal Reserve Flow of Funds) minus 70 percent of residential investment spending (from the BEA)

Charts showing trend in amount of credit card debt outstanding, average interest rates and carryover balances.

Regulation

Consumer advocates insist that too few underwriting standards exist for issuing loans. Regulatory standards have generally been lax in this country, and advocates resoundingly are calling for smart reform. The matter of credit card reform has been actively debated in Congress in the past couple of years. Given the current worries over financial markets, the issue is likely to be addressed in the near future. Indeed, President Barack Obama has proclaimed that the financial system has "failed the test of the marketplace."

Another sign that the winds of change are blowing comes with the release of the Group of Thirty's "Financial Reform: A Framework for Financial Stability." The document, whose authors include Paul Volcker, an economic adviser to President Obama, emphasizes the need to re-regulate global finance (Fitzgerald) and advocates for increased oversight and greater transparency in financial markets. The document also urges regulators to curb reckless lending by forcing banks to retain a larger portion of credit risk when loans are packaged into securities. (Financial Reform)

Future changes in the regulatory structure would in all likelihood force financial institutions to take more responsibility for their own credit risk instead of allowing them to repackage risky debt into securities. But these concerns would be weighed against the need, both for individuals and for the greater economy, to provide consumers some ability to borrow. Overregulation is still undesirable because in the absence of legitimate consumer access to credit services, business conditions will falter. Furthermore, credit card lenders, payday loans and mortgage brokers should operate in a healthy environment that would allow consumers access to a wide array of services whereby penalties and fees would be made clear to the borrower.

Some proposed regulatory standards are: (1) restrict industry-wide credit card lending standards so that criteria such as income and credit history play a role in lending decisions; (2) limit the number of payday lending advances a borrower can have outstanding at one time; (3) put maximum limits on interest rates, fees, and penalty charges; (4) address the securitization of debt which allowed mortgage backed securities to crash; (5) put special restrictions on terms for student aid. (Federal Trade Commission 26; Mantel 209; Wheary and Draut 8; Financial Reform 14)

Graphic summarizes the options Treasury Secretary Timothy Geithner has to fix the ailing U.S. banking system.

Most consumer advocates agree that many consumer debt problems can be solved by an otherwise healthy economy. If income levels rise, and jobs and affordable health care are made available, overall levels of consumer debt should respond accordingly. The key to a better system of credit is the pursuit of more accountability at all levels - from governance and social responsibility in business to consumer advocacy and education efforts. The end result could be improved consumer welfare as well as a better outlook for the economic well being of the country as a whole.

List of Visuals

1. Consumption Spending and Mortgage Equity Withdrawal as % of GDP
   Consumption and GDP data from the Bureau of Economic Analysis (BEA). Mortgage equity withdrawals are measured as the year-over-year change in mortgage debt (from the Federal Reserve Flow of Funds) minus 70 percent of residential investment spending (from the BEA).
   http://theboard.blogs.nytimes.com/2008/04/24/look-out-below/
   L. Josh Bivens, Economic Policy Institute

2. Behind Credit Card Reform
   Charts showing trend in amount of credit card debt outstanding, average interest rates and carryover balances.
   Knight-Ridder/Tribune News Service 09-23-2008, Taken from Proquest's eLibrary

3. What Will Geithner Do
   The options Treasury Secretary Timothy Geithner has to fix the ailing U.S. banking system.
   Knight-Ridder/Tribune News Service 01-27-2009, Taken from Proquest's eLibrary


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