sigh. more on usury.

As I said in the comments to Travis’ post, Rachel Anderson’s definition of a bad loan is wrong. Banks mostly lose money on bad loans – the fees and penalties simply limit the amount of losses. These are only “extra” profits if the borrower is somehow able to turn it around and eventually pay back most if not all of the principal. This doesn’t usually happen.

A much harder scenario is this: Say you are actually a scrupulous banker, but since you are a large bank, you need to provide guidelines to several hundred loan officers about how to approve a loan based on any application you want to design. How do you do it? How do you know a person will pay you back? Remember, not only do you have to give this guidance to hundreds of people, but they will themselves be dealing with hundreds of customers. Most big banks do not do “relationship banking” with individual consumers, so you can’t use that. You’ve got a paper application and perhaps an hour interview. What do you want to know?

Then, what do you tell your hundreds of loan officers to do when they are each dealing with hundreds of defaults? Mass forgiveness? If you get a reputation for that, then you’re a sucker who will attract unscrupulous borrowers (yes, those exist also). I think you may have some sort of penalty for non-payment to deter the worst borrowers from attempting fraud – it is easier to prevent the prosecute after the fact.

The false dichotomy here is one of a “good” lender who forgives debts and a “bad” lender who imposes penalties for non-payment. Yes, there are unscrupulous bankers, but I doubt they consist of a majority of employees or loan officers at big banks. Most of them are trying to deal with a very difficult scale problem. Economies of scale allow lower borrowing costs – that is why big banks exist. But to scale up, they need to deal with people in large groups based on common characteristics.

We are talking about big banks and mass lending. Scale is a big, big problem when you are talking about things like forgiving debts, fines, penalties and like. How do you tell the difference between someone who is genuinely in need versus someone telling you a story who is just trying to sucker you?

Anyone who has been approached for money on the street has faced this problem. Let’s say you could talk to the person requesting money for an hour. What would you ask to determine if they were honest or lying? Let’s say you could force them to provide documentation. What would you want to see? Then, you make the decision on the spot to “loan” them money. Now, let’s say this is your business. How will you make enough to have money to pay your mortgage?

That is why I advocate the use of local community banks – you get more context and relationship. Trying to impose context and relationship on big bank lending is a waste of time. If you want less “usury” as defined as penalties and high interest rates for risky borrowers, then let’s focus on the financial regulation legislation and see if we can get a cap on bank size to start with.

Comments on Dan’s article

I just posted this in the comments section of Dan’s article to which Travis just referred:

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1. Caps on interest rates will cause credit rationing – meaning limiting access to credit. This means that for all of the examples of people stuck with high interest credit card debt, you need the alternate scenario to be what their situation would have been if they had no way to get a credit card at all. The alternate scenario is not a credit card at 10%. For some, this is a feature, not a bug (i.e. living beyond their means) but for others (just trying to pay their bills) this is a personal tragedy involving eviction, loss of utilities, etc. Is that better or worse than what we have now?

2. Usury can only exist in the presence of market power or collusion. If many banks across the country are charging about the same rate to the same people, I’m more inclined to call that a market rate, otherwise one of these banks could lower it from 21% to 19%, advertise and get all of the ‘profitable’ customers. Those who claim a high interest rate is usury need to explain why this isn’t happening. Are the big banks colluding? If a high risk borrower with a lot of debt and a 21% interest rate is so profitable, why doesn’t a small local bank then offer 19% to steal them away and make the profit? There are, literally, thousands of banks in the US, so I have difficulty believing that market power exists in setting interest rates, thus I have difficulty calling it usury.

3. The reason why I am opposed to the actual setting of an interest rate cap is that I think we will take the most marginalized and move them from a high market interest rate to a true situation of usury. When someone cannot go to the market to get a loan, and they need money to pay their bills, they go to more, ahem, ‘creative’ means – i.e. illegal. *Then* you have market power and usury. Tony Soprano can charge whatever interest rate he likes and he doesn’t use actuarial tables. This happens because we limit the interest rates banks can legally charge, then the highest risk people are denied credit altogether. Those who are truly in need either don’t pay their bills and are evicted, or they go to payday lenders and loan sharks. I’d rather have the status quo.

Now, I have no problem in raising awareness about interest rates and the concept of usury. Re-introducing it to our vocabulary is a good idea in my opinion. Actually setting caps on interest rates is a bad idea.

What do I propose instead?
1. Let business be business and charity be charity. We, the church, should steal their customers. People living beyond their means need financial counseling and the act of discipline and contrition in paying off the debt they got themselves into is probably a good thing. People truly in need the church needs to help pay their bills without debt – as a previous commenter noted, this isn’t sustainable for them anyway.
2. We need to advocate for education and jobs. People with a steady income are generally lower credit risk and get lower rates for short term borrowing.
3. Address the materialism and other idols we know exist in our communities. Many Americans do live beyond their means on cheap credit. Even for those with manageable interest rates, this is not good for their soul.

Move Your Money campaign

My wife and I recently opened a checking account at the North Carolina State Employees Credit Union and will be closing our Wachovia account. Why? Fees, fees, and more fees. We had a simple checking account, but to access my own financial information via Quicken, Wachovia wanted $6 per month.  SECU charges a $1 monthly maintenance fee which somehow feels to me more transparent, reasonable, and actually for the service they provide. The large national banks seem to think they can just alter fees to make more money rather than simply charge for a service. Add on to that the sometimes ugly behavior of the big banks with regards to overdraft fees, mortgage mods, and compensation, and we’re done.

Little did I know that there was a Move Your Money campaign started by the Huffington Post. They are encouraging people to take the pledge to move their money out of big banks, to local community banks and credit unions. I’ve not signed the pledge, but did take the action. Tim Geithner has commented, somewhat awkwardly.

I recommend you do the same. The only inconvenience is the ATM network, so if you are a heavy user of cash, perhaps that’s a problem for you.

the decline of credit cards

I’ll just reproduce this post in its entirety since I can’t say it any better:

Ezra Klein, on what he considers a vicious cycle in credit cards:

The problem is that the people who migrate toward debit cards are the people who have enough money not to need much credit and are responsible enough to not want it. The good risks, in other words. The people left in the credit card market will be disproportionately bad risks, which means rates will go up and standards will tighten, which will in turn drive more people out of the market, starting the cycle over again.

I’m not convinced that this is a bad thing. Credit cards are useful payment devices, but atrocious borrowing devices. (Steve Waldman has a great post explaining the distinction further.) We want to move to a world where people use charge cards for transactional purposes, and personal loans for credit purposes. The way we’re going to get there is, essentially, by taxing the stuff we want less of — and that means increasing the interest rates and annual fees on credit cards.

Sometimes this is going to happen in an underhand and less-than-honest way: Odysseas Papadimitriou has a great blog entry on how Bank of America is denying that introducing a $50 annual fee constitutes a repricing of its credit cards, for instance. But the big move, away from credit cards and towards alternate means of payment and sources of credit, is surely to be welcomed.

The sad aspect to all this is that millions of people hold large credit card balances and have no ability to refinance them with personal loans, or even any particular notion that such a thing might be possible. They’re going to be harmed by this move. But over time, if things go right, their numbers will naturally dwindle, and we’ll be left with a much healthier system of consumer finance.

how to beat overdraft fees

Another way we can help the underserved – reversing overdraft fees. Many folks who are at the margin run their bank accounts close to overdraft. And many big banks (not so much Community Banks or Credit Unions) will charge a separate $30 overdraft fee for every transaction. So heaven forbid you go run some errands when your balance is close to zero, because you’ll go to say three stores, buy a handful of things, and find out they cost you $90 more than you thought.

What can you do? Take your bank (even Wells Fargo/Wachovia) to small claims court. In almost all cases, they will refund the fees rather than fight you. But note ahead of time, they will also want to close your account, so be ready to switch. This is probably intimidating for many people but it’s not that hard. And the more people do it, the more likely banks will change their policies.

HT: Felix.

Ten Percent is Enough

So, here is the document, much discussed at Emmaus Way (my comments below):

View this document on Scribd

Some random comments:

1. Technical note, but important enough to mention. Even if some sort of usury law gets enacted, it will have to be a floating rate above the Federal Funds rate – in the early 1980′s, fed funds was itself almost 10%, so a fixed 10% rate will never work. Then, there will be confusion amongst those who wonder how if we capped rates at 10%, they can have a credit card at 15% (the answer: Fed Funds is at 5%!).

2. I was a bit disappointed that this document focuses on “Big Banks” as bad guys. While I appreciate and agree that the large financial institutions have behaved badly in many ways, this is only a partial answer. The reality is that American Consumer Debt is somewhere close to 100% of GDP, and it has not been that high since the Great Depression. It seems to me that as Christians, we need to focus on why people have so much debt, not trying to negotiate lower rates. I would have preferred a tone of “forgive us all, for we have sinned” over “we need to tell these big banks to stop beating up the little guy.”

3. If we really want to help people, and the people of Durham, NC (where our church is) are  burdened by high interest rates, then we need to start a Community Bank. If the interest rates charged are unnecessarily high, then a local, non-profit, community bank can charge lower interest rates and we simply take customers away from the larger, high interest banks. We could even partner with Self-Help, which does basically the same thing for mortgages (and may already do community banking).