The Two-Income Trap (20 page)

But the story doesn’t end there. The banking lobbyists were persistent. President Clinton was on his way out, and credit card giant MBNA emerged as the single biggest contributors to President Bush’s campaign.
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In the spring of 2001, the bankruptcy bill was reintroduced in the Senate, essentially unchanged from the version President Clinton had vetoed the previous year.

This time freshman Senator Hillary Clinton voted in favor of the bill.

Had the bill been transformed to get rid of all those awful provisions that had so concerned First Lady Hillary Clinton? No.
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The bill was essentially
the same, but Hillary Rodham Clinton was not. As First Lady, Mrs. Clinton had been persuaded that the bill was bad for families, and she was willing to fight for her beliefs. Her husband was a lame duck at the time he vetoed the bill; he could afford to forgo future campaign contributions. As New York’s newest senator, however, it seems that Hillary Clinton could not afford such a principled position. Campaigns cost money, and that money wasn’t coming from families in financial trouble. Senator Clinton received $140,000 in campaign contributions from banking industry executives in a single year, making her one of the top two recipients in the Senate.
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Big banks were now part of Senator Clinton’s constituency. She wanted their support, and they wanted hers—including a vote in favor of “that awful bill.”

There is one final chapter in the story of how millions of seemingly ordinary, middle-class families found themselves falling off a financial cliff. Just at the time when parents got caught in a vicious bidding war for middle-class housing, just as the cost of college tuition and health insurance shot into the stratosphere, just as layoffs increased and the divorce rate jumped, a new player appeared on the scene. A newly deregulated lending industry emerged, eager to lend a few bucks whenever the family came up short.

Pick up almost any newspaper, and there will be a story about America’s most widespread addiction: the insatiable hunger for debt. Every year for the past decade, mortgage debt has set a new record.
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Home equity loans grew even faster, increasing by over 150 percent in just four years.
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And no one would dare leave home without a fistful of those little plastic cards.

The news media rarely give any explanation for
why
all that debt piled up, leaving the reader to infer that the debt explosion is some sort of inevitable by-product of today’s moral and economic climate. But Americans didn’t wake up one morning and decide en masse that they needed stuff so much that they’d be delighted to take on a big fat
second mortgage and that they’d be thrilled to skip a credit card payment or two, as the headlines might imply. Nor was there a sudden “national conspiracy of people who buy credit cards and then max them out,” as one professor of finance claimed.
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Those mountains of debt were made possible by one very important change that largely went unnoticed in all the discussions about Americans and debt—a seemingly small modification in the laws of consumer finance, a tiny change that transformed centuries of family economics in an instant.

Just a generation ago, the average family simply couldn’t get into the kind of financial hole that has become so familiar today. The reason was straightforward: A middle-class family couldn’t borrow very much money. High-limit, all-purpose credit cards did not exist for those with average means. There were no mortgages available for 125 percent of the home’s value and no offers in the daily mail for second and third home equity loans. There were no “payday lenders,” no “live checks,” no “instant money,” and certainly no offers to “consolidate” all that debt by moving it from one credit card to another. A generation ago, a family that wanted to borrow money had only a handful of options. Instead of running up debt anonymously, a prospective borrower was forced to meet a stern-looking banker, face-to-face. Families were asked to produce past tax returns and pay stubs, credit references, and projected budgets that showed how they planned to repay the money. If they wanted to take out a mortgage for a new home, they were typically required to come up with a 20 percent down payment from their own savings.
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If they wanted money for any other purpose, they were required to give a detailed account of their spending plans, and the banker had a fairly narrow set of answers he wanted to hear: building an extra bedroom on the house, buying a new car, sending the twins off to college. Some retailers offered credit to move their merchandise, but cash loans and lines of credit for “making ends meet until John finds a new job” or “putting groceries on the table until the child support checks begin” were not in the lending lexicon.

The reason for the lenders’ cautious approach was not that the bankers of yesteryear were thriftier or that Americans hadn’t yet developed
a taste for “unbridled consumption.”
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The reason was a far more powerful one, and it affected every lender and every borrower in the country: The law was different. In those days, the banking industry was highly regulated, and usury laws created ironclad limits on how much interest a bank could charge on a loan. As a result, banks’ profit margins were modest, and families that wanted to borrow money had to prove they had a very high likelihood of repaying it.
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The judgment was not moralistic; it was supported by stubborn financial reality. Unlike today, bank vaults were firmly closed to families already in financial trouble.

From the founding of the Republic through the late 1970s, interest rates had been a matter for states to determine, and the states had imposed limits on the amount of interest that could be charged on consumer loans.
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The logic behind the laws was straightforward: State governments wanted to protect their citizens from back-alley loan sharks and aggressive lenders who would cost families their homes.

But the states’ authority to regulate lending within their borders was wiped out by an obscure federal regulation. In 1978, a Supreme Court opinion interpreting some ambiguous language in a little-known federal statute opened the door for banks to “export” interest rates from one state to another.
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This meant that a bank with lending operations in South Dakota—where the interest ceiling was 24 percent, at a time when the rates in most states were capped at 12 to 18 percent—would have a distinct advantage. A South Dakota bank could now issue loans at 24 percent interest to a family living in New York (where rates on most loans were capped at 12 percent), without worrying about the corporate officers ending up in a New York prison next to loan sharks who collected by breaking people’s fingers until they paid. Under the new law of the land, South Dakota banks could collect their profits from New York families, and there wasn’t a thing the New York legal system could do about it.
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The race was soon on. Local politicians across the country quickly figured out that all they had to do was raise the interest rate ceiling, and lending institutions would flock to their states. Suddenly there was a new way for states to attract clean, white-collar jobs, and even grab a
share of corporate taxes in the process. Sure, there might be some hardship for families that stumbled into high-interest loans they really couldn’t afford. But most of the hardship would be exported to the residents of other states, while the benefits—jobs and tax revenues—would stay local. By way of analogy, consider America’s drug laws. Suppose that South Dakota passed a law (and the federal government permitted it) that made it legal to grow marijuana inside the state and to sell it anywhere in the country. South Dakota would bear only a tiny fraction of the total social costs of marijuana use, while reaping 100 percent of the profits for sales elsewhere. Suddenly the downside of marijuana use that once made legalization unthinkable—drug addiction, health problems, traffic accidents, and so forth—might start to look pretty insignificant next to all those dollars the state could rake in.

Lenders also began to see the possibilities opened up by the new laws. No longer would credit be a prized commodity, doled out parsimoniously. By the mid-1980s, credit had become a highly profitable consumer product, like running shoes or soft drinks, and the new game was to sell as much as possible.
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How to manage the risk that some customers might default on the debt? Simple: move the lending operations to South Dakota—or Delaware, which quickly followed South Dakota’s lead—and then raise the interest rates for customers across the country.
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Banks would “lose” money on some credit card customers, but, thanks to higher interest rates, those losses would be more than offset by the profits on the rest. Over the past decade, bad debt losses and loan write-offs have soared, but profits have risen even faster.
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In this new sky’s-the-limit world, the stern-faced banker and the long application forms have been replaced by chirpy advertisements and “preapproved” credit offers. Banks can now lend to anyone and everyone (including those in financial trouble) and still make a handsome profit.

In the new world of unregulated lending, families are barraged with advertisements and offers for a new product: all the debt they could
ever want, and more. Now, in a single year, more than five
billion
preapproved credit card offers—totaling over $350,000 of credit
per family
—pour into mailboxes all across America.
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Magazine ads, telephone calls during dinner, and flyers at the bottom of grocery store bags barrage families with even more offers of credit, while roving bands of credit card marketers haunt college campuses and shopping malls. Credit card debt has increased accordingly: from less than $10 billion in 1968 (inflation adjusted) to more than $600 billion in 2000, an increase of more than
6,000 percent
.
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It would seem that once Americans got a first bite of the debt apple, they just couldn’t get enough.

But what are families spending all that money on? Did they blow it on “vacations and luxury items,” as one columnist claimed?
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This explanation might gratify the self-righteous bill-payers, but it doesn’t square with the facts. Undoubtedly, all that easy credit dangling under everyone’s noses enticed a few more Americans into buying things they could have lived without. As we showed in chapter 2, today’s families are spending more on some goods, such as computers, home electronics, and pet food, than they did a generation ago. But they are spending less on food, clothing, appliances, home furnishings, and tobacco—a lot less. There is no evidence of an increase in impulse buying or luxury acquisitions over the past thirty years—certainly nothing that could account for a 6,000 percent increase in credit card debt. Moreover, the expenditures that have shown the biggest increases—e.g., housing, health insurance, college tuition, preschool—are the purchases
least
likely to appear on a credit card bill.

If families aren’t buying more goods, then what are they using all that debt for? They get into debt trying to buy their way out of the Two-Income Trap. The bidding war has inflated the cost of middle-class life to the point that once they have paid the mortgage and other fixed expenses, families have little discretionary income left—and even less margin for error. What to do when something goes wrong, as it increasingly does? Since the two-income family does not have a stay-at-home mom to call on to help make ends meet when
emergency strikes, the family turns to debt to make it through to the next payday.

No advertisements trumpet, “When your husband leaves you, there’s MasterCard.” Nor do we hear: “American Express: Don’t lose your job without it.” But those slogans would be closer to the truth about how credit is used today. When corporate layoffs loom, workers apply for as many credit cards as possible to see them through until they can find a new job.
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When health insurance lapses, the family hands a MasterCard to the doctor and prays for the best.
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And when Dad walks out, that “E-Z check” stuffed in with the latest credit card bill looks like just the thing to tide Mom over until the child support checks arrive. Later, when the credit card payments become unmanageable, the family takes on a second mortgage to consolidate all that debt. No one would suspect it from looking at the ads, but for every family taking out a second mortgage to pay for a vacation, there are sixty-one more families taking on a second mortgage so they can pay down their credit card bills and medical debts.
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The bankruptcy court offers a peek at those in the most trouble with debt. The Myth of the Immoral Debtor would have us believe that these families consumed their way into bankruptcy, running up their credit cards to cover their “reckless spending.”
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They are at least half right; families in bankruptcy are choking on credit card debt. Ninety-one percent of the families in bankruptcy were carrying balances on their cards by the time they filed. A third of homeowners were carrying second or even third mortgages or had refinanced their mortgages to get some cash.
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The amount of debt was truly staggering. Nearly one-third of bankruptcy filers—more than 400,000 families—owed
an entire year’s salary
on their credit cards, a hole that was virtually impossible to dig a generation ago.
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But the critics are off the mark on one point—the role played by over-consumption or its ubiquitous cousin, “trouble managing money.” By 2001, those two reasons combined to account for less than 6 percent of families in bankruptcy.
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What about the rest? The overwhelming majority of bankrupt families faced far more serious
problems. As we showed in chapter 4, nearly 90 percent had been felled by a job loss, a medical problem, or a family breakup, or by some combination of all three.