Richard Posner, federal judge, professor at the University of Chicago, father of the law and economics movement, and now a blogger as well, has added his voice to the debate on bankruptcy reform. Here is a list of his key points:
- Critics have derided the Act as mean-spirited and hard on the poor, but they overlook the most important effect that the bill is likely to have, and that is to reduce interest rates.
- If bankruptcy is more costly, there will be less of it.
- If one is already borrowed to the hilt, an unexpected medical expense may indeed force one over the edge. But knowing that medical expenses are a risk in our society, prudent people avoid loading themselves to the hilt with nonmedical debt.
- the Bankruptcy Reform Act will encourage consumers to exercise greater care in borrowing—yet at the same time, because interest rates will be lower, the Act will enable prudent consumers (who do not face a high risk of bankruptcy) to borrow more and by doing so will increase their consumption options. The Act will not redistribute wealth from the poor to the rich, but from the imprudent borrower to the prudent borrower.
Posner and Becker’s entire discussion rests on the standard chestnut that the bankruptcy bill will benefit consumers because it will reduce creditors’ risk and therefore cut interest rates. That argument not only ignores twenty years of data; it also perpetuates a plodding “perfect markets” model of consumer credit that most theorists have long since abandoned.
First, she shows that credit card companies pocket profits from cost-savings rather than passing those savings on to consumers:
Bankruptcy write offs represent about half of the total bad debt writes, which would suggest that they ranged from 1% in 1985 to 2.5% in 1992. Much larger is the cost of funds, which is the amount companies must pay to borrow the money they lend out. From 1980 to 1992, that cost fell from 13.4% to 3.5%, a stunning decrease in costs. What happened to the interest rates the companies charged? In the same time period, the average credit card interest rate rose from 17.3% to 17.8%. Move the clock forward a bit. When the cost of funds dropped nine times in 2001, instead of passing along the cost savings, the credit card companies pocketed a windfall of $10 billion in a single year. So much for the idea that the credit card companies are lined up to pass savings along to the customers.
She then shows that credit card companies do not want to create a market in which consumers will exercise greater care in return for lower interest rates. In fact, they obfuscate their lending practices behind a 30 page contract which makes it virtually impossible for even a “prudent borrower” to know what their interest rates actually are:
The credit card companies have fought like tigers to avoid telling customers the basics—if you make the minimum monthly payment, you’ll pay $xx in interest and it will take you xx years to pay it off. This non-closure is so that credit card companies can compete to lower fees?
She continues by citing several studies by economists which show that “credit card companies use dozens of tricks in their contracts to encourage customers to underestimate costs and overestimate their repayment schedules.” This is possible because, as studies of consumer behavior show, “while people will shop for introductory interest rates, they are far less likely to re-shop when new fees and penalty rates are imposed on them.” All this leads to a business model based on essentially luring customers into paying unwanted fees — and it is a very profitable business model:
The lesson is clear: credit card companies can maximize profits by pricing introductory rates competitively and then hitting customers hard later on with fees and penalties. And that model certainly seems to fit the data on revenues. Today, credit card fees and late charges amount to $50 billion—about half of all credit card revenues.
The most absurd part of Posner’s discussion is the claim that “prudent people” will avoid racking up credit card debt so that when they have a medical emergency they won’t already be saddled with huge amounts of debt. But how are prudent people supposed to even plan for medical expenses when their employers continue to cut benefits — even benefits that they had counted upon after retirement?
For many of America’s retirees, paying the soaring costs of healthcare is possible only with the help of their company’s retirement package—benefits they counted on for life. Today, many companies are moving to cut benefits and shift costs to retirees, forcing some to drop out of coverage and others into court to save benefits they thought were guaranteed. Corporate lawyers are filing preemptive lawsuits against former employees and relying on interpretations of fine print to make their case in court with greater and greater success.
As Elizabeth Warren points out, without any kind of universal heath insurance, it is impossible to argue that giving credit card companies tougher bankruptcy laws is somehow in the consumers own interest.
Europeans have universal health insurance, better unemployment protection, and tougher bankruptcy laws; to make the bankruptcy laws in the U.S. tougher when shrinking health insurance coverage and growing unemployment and outsourcing tear away at middle class families is simply to ignore facts that don’t fit the model.
ELSEWHERE: See my last post on the topic.