Economics Makes Strange Bedfellows

In discussing the bankruptcy bill, Noam Scheiber finds himself  on the same side of the economic issue as deputy White House spokeperson Trent Duffy.  We will let Mr. Duffy speak first:

"The administration supports the passage of bankruptcy reform because ultimately this will lead to more accessibility to credit for more Americans, particularly lower-income workers," said Trent D. Duffy, a deputy White House spokesman.

Stricter bankruptcy laws promote greater availability to credit, and move us away from the days when the old saw was that banks only lend money to people who don't need it.  But maybe that is a bad thing - here is Mr. Scheiber:

The front page of today's Wall Street Journal has an interesting article about bankruptcy laws. The basic idea is that there's a moral hazard problem associated with lending money: If a credit card company knows that strict bankruptcy laws will help it recover money lent to bad credit risks, it faces little incentive to avoid extending them credit. By tightening the nation's bankruptcy laws, the bankruptcy bill about to pass Congress could have the perverse effect of creating even more bankruptcies, because there will be a smaller disincentive to lend to un-creditworthy people. (Or is that credit-unworthy?)

Well, yes, as Mr. Duffy noted - lending to the less credit-worthy becomes more attractive if bankruptcy laws are made more strict.  And the key qualifier in Mr. Scheiber's summary is "help" - stricter laws won't squeeze water from a stone, and the proposed changes in this law won't affect most filers, if Prof. Zywicki's numbers are accurate.

Now, it may be that Democrats generally would prefer to see less lending to lower-income groups.  However, that is a bit counter-intuitive, and somewhat at odds with their positioning on issues such as credit redlining.   

In fact, Sen. Carl Levin wrote about credit card redlining in 2000, and seemed to be worried about "the problem of unequal credit opportunity."

Perhaps, per Mr. Scheiber, the position of the Democratic Party has changed.  Or (my guess), perhaps opponents of stricter bankruptcy laws would prefer that credit be made available to low-income folks by means of Congressional intercession and jawboning.

I can't find the results of the Federal Reserve Bank study that Sen. Levin wanted to fund; since this bill failed, perhaps the study was never done, but I would think someone has looked at this.

MORE:  The DOJ from 2001 offers this advice to lenders, including credit card lenders:

Those who develop and use credit scoring models should take care to determine whether individual credit scoring factors or the overall systems have a disparate adverse impact on minority and other borrowers in protected classes and, if they do, whether other factors or formulations with lesser impact can be used with similar capability to predict creditworthiness.

The report also cites several enforcement actions.  A possible inference - it is safer to lend than to be sued by the Feds.

Let's note - the caution applies to "disparate impact".  So, even if the credit scoring model is color-blind, if a bank rejects "too many" black people on the basis of low income, they may have a problem.

Comments

[Tollhouse]

Here's a question, how does one prove to the lender's satisfaction that one is a minority? I wouldn't mind getting a home loan, but since I'm white the bar is a bit higher. Is there a checklist that is followed? One drop rule?

[The Kid]

The bankruptcy bill will allow those who now must rely on sub-prime lenders – cash advance, payday advance, car title loan, furniture rental, and other upstanding lenders – to start with conventional credit accounts: even 25% is lower than what they’re paying now. The key to sub-prime lending success is to establish a personal relationship with the borrower to increase the probability that the loan will be repaid. That’s why such lenders operate out of storefronts in less desirable neighborhoods – a centralized operation would go broke in a skinny minute.

With banks expanding their offerings, the sub-prime will face a squeeze; they’ll have to go after even riskier prospects and up their enforcement capabilities.

Victor, Vinny, you’re wanted on line 1.

[gt]

There is a dearth of unsecured lending? You sure?

[TM]

I'm stumped, GT - who is suggesting there is a dearth of unsecured lending?

Noam Scheiber seems to think that stricter bankruptcy laws might lead to even more lending - perhaps he thinks that currently there is a dearth?

I happen to think that he is noting an economic truism. As to whether the current amount of lending is dearth-like, just right, or too much, how would one tell?

[TM]

These all look like great links, as soon as I figure out point I am trying to make:

http://www.federalreserve.gov/releases/g19/hist/cc_hist_r.txt

http://www.federalreserve.gov/releases/g19/hist/cc_hist_sa.html

http://www.federalreserve.gov/releases/g19/current/default.htm

http://www.federalreserve.gov/releases/housedebt/default.htm

[Forbes]

I think this argument all wet.

Under such an argument, credit card companies identify consumers that are bad risks, and it is the extension of credit that turns those consumers into deadbeats. In this view, there's only one player that acts irresponsibly--credit card companies--and there's only one way to protect consumers from this irresponsibility--allow deadbeat consumers to shed their credit card debt via bankruptcy proceedings.

And it is only the bankruptcy threat that prevents credit card companies from extending credit to even less worthy consumers. (Otherwise, where will the presumed increase in bankruptcy filings come from?)

By Scheiber's reasoning though, bad credit risk has a malleable definition. He identifies bad credit risks as those consumers that credit card companies should have a "disincentive to lend to", while at the same time suggesting that "strict bankruptcy laws will help it recover money lent to bad credit risks."

Such a definition of bad credit risk isn't credit scored (means-tested), it's ends-tested--those that actually file bankruptcy.

The straw foundation of this argument begins with predatory lending as fact, while stacking on top of it the perversion of “moral hazard,” whereby better bad debt recovery for credit card companies will result in credit extension to not just deadbeats, but to those barely breathing. (And apparently no one can resist spending their new credit card right up and over the credit limit the very day it arrives in the mail.)

(As an aside: This is a bastardization of the usage of moral hazard which generally means third-party taxpayers assuming the credit risk backstop, whether in the form of IMF bailouts in a sovereign debt crisis, or the federal government providing flood insurance.)

At the end of the day, the new bill is perverse because it might result in more bankruptcies—so Scheiber suggests—because it’s a fact that credit card companies can’t resist extending credit to whole classes of the American economy that are just to stupid to know what a credit limit is, how interest is charged on outstanding balances, and why over-limit and late payment fees are charged.

/rant off

[dsquared]

I happen to think that he is noting an economic truism. (emphasis added)

I like "jumbo shrimp" and "military intelligence" better.

Today's cryptic off-the-cuff remark brought to you by the sentence "Internationally or in time series, differences in bankruptcy codes really don't seem to have any explanatory power at all".

[Aaron]

Forbes,

The problem is that the moral hazard works both ways:

a. generous bankruptcy laws makes credit card companies careful, but consumers know they can abuse their credit.

b. stringent bankruptcy laws make credit card companies more willing to lend, possibly even to those with bad credit.

[Forbes]

Well, Aaron, that's only if you believe the concept of moral hazard as offered. I don't. Point of matter, all you've done is restate Scheiber's argument which poses as a fact that which is merely an assumption.

First of all, your suggestion that it "works both ways" assumes that the only change in behavior--in response to the change in the law--is by credit card companies. Supposedly, all that is preventing credit card companies fron lending to consumers with bad credit are the losses suffered from consumers that abuse their credit and find reprive in bankruptcy. The assumption, here, is that those that find themselves in bankruptcy are bad credits, although it equally appears as a consession in all such arguments that consumers use bankruptcy to avoid repayment of the credit they've abused. (In fact, I would say this is a "one-way" argument, for you've posed the one way (more lending to bad credits), conditions will change in response to the change in the law--that's hardly "both ways," IMO.)

Such a proposition presumes a lack of response--a lack of free will on behalf of the consumer, i.e. that consumers are naturally irresponsible, and that any additional lending that occurs as a result of tightening the bankruptcy law can only result in lending to more irresponsible consumers.

Another failure of this "moral hazard" argument, as I said in my earlier post, is that it is a bastardization of the term. The concept of moral hazard is invoked where the government, on behalf of taxpayers who ultimately suffer the cost, induces below cost prices on markets. IMF credit backstops to sovereign governments induces over-borrowing by those governments by means of lower interest rates set by lending banks--banks that are bailed out by the IMF (taxpayer) in the event of a crisis resulting from overly burdensome government debt obligations.

Government-subsidized flood insurance induces people to develop property in flood plains and coastal areas with little risk of loss to the property owner in the event of a flood or other weather-related disaster. Taxpayers pay the recovery cost when the losses occur at little risk to the property owner.

What is really being posed here--and for which this "moral hazard" argument has been substituted--is the rule of "unintended consequences." It sounds like a superior argument by substituting "moral hazard," as unintended consequences are usually spoken of after the fact as unforeseen, but properly analyzed, should've been anticipated. It is also an incredibly weak argument to suggest not following a course of action due to the "unintended consequences," especially as said consequences are an assumption based on credit card companies as predators, and consumers as irresponsible. I think it's just possible to take a slightly less frenzied outlook when forging an argument based on such a subjective analysis.

Now, let me take such an argument one step in the right direction. The unintended consequences in the original post referred to the suggestion that the number of bankruptcy filings might increase as a result of the reform.

(This, I suggest, is a part of the straw man argument against the bill--that a purpose of the bill is to reduce the number of bankruptcies--and "See, we've shown how the number of bankruptcies will go up, bad bill." Well, no. The purpose of the bill is to reduce bankruptcy abuses, and if there are abuses, then it will reduce bad debt write-offs suffered by credit card companies. A possible, but not necessary, result is a reduction in bankruptcy filings. The lawyerly contributors to this discussion has suggested that the reform will mean fewer people will abuse the process because fewer people will get complete liquidations of their debt, and bad debt recoveries will go up--bad debt write-offs will go down. But the starting point in this argument is an admission that people abuse the process, so the number of bankruptcy filings will likely decrease as a result of a stricter law.)

So the argument would have to be that the total bad debt losses--not the number of bankruptcy filings--incurred by the credit card companies, would be higher, as a result of the bankruptcy reform bill. I don't think that argument can be made.

I think the policy argument for this bill is to help make credit more widely available through the reduction of abuses that are occurring via the complete liquidation provisions of the existing bankruptcy law.
And in a logical sense, the only way to make credit more widely available is to allow, via bankruptcy regs, more profitable opportunities for credit card companies by means of stricter bad debt recovery.

(Blah, blah, blah...get your own blog.)

[Debt]

Debt: "How To Get Out Of Debt By: John Mussi "

Debt: "Eliminating Credit Card Debt By: Alan Barnes "

Debt: "We all know about debt. If you don't have too much as an individual you can increase the quality of your life,"