Unsafe at Any Rate
If it’s good enough for microwaves, it’s good enough for mortgages. Why we need a Financial Product Safety Commission.
Nor are all costs associated with debt measured in dollars; not surprisingly, the effect on family life is considerable. Anxiety and shame have become constant companions for Americans struggling with debt. Since 2000, families have filed nearly 10 million petitions for bankruptcy. Today about one in every seven families in America is dealing with a debt collector. Mortgage foreclosures and credit defaults sweep in millions more families. How do they feel about their inability to pay their bills? The National Opinion Research Council asked families about negative life events, on a ranking of one thorough 100: Death of a child (94.3) and being forced to live on the street or in a shelter (86.7) topped the list, but filing for bankruptcy ranked close behind (83.5), more serious than death of a close friend (80.8) or separating from a spouse (82.1). About half won’t tell a friend their credit card balances, and 85 percent of those who file for bankruptcy are struggling to hide that fact from families, friends, or neighbors.
Why do people get into debt trouble in the first place? People know that credit cards are dangerous, all the more so if the customer carries a balance. Mortgage financing is a serious undertaking, with reams of documents and papers; any consumer who signed papers without reading carefully or seeking legal assistance should not be surprised if terms come to light later that are unfavorable to the consumer. Payday lenders have a bad reputation for taking advantage of people; no one should expect to be treated well by them. Car lenders, check-cashing outlets, overdraft protection–the point can be repeated again and again: Financial products are dangerous, and any consumer who is not careful is inviting trouble. And yet, dangerous or not, millions of Americans engage in billions of credit transactions, adding up to trillions of dollars every year.
Some Americans claim that their neighbors are drowning in debt because they are heedless of the risk or because they are so consumed by their appetites to purchase that they willingly ignore the risks. Surely, in such circumstances, it is not the responsibility of regulators to provide the self-discipline that customers lack. Indeed, there can be no doubt that some portion of the credit crisis in America is the result of foolishness and profligacy. Some people are in trouble with credit because they simply use too much of it. Others are in trouble because they use credit in dangerous ways. But that is not the whole story. Lenders have deliberately built tricks and traps into some credit products so they can ensnare families in a cycle of high-cost debt.
To be sure, creating safer marketplaces is not about protecting consumers from all possible bad decisions. Instead, it is about making certain that the products themselves don’t become the source of the trouble. This means that terms hidden in the fine print or obscured with incomprehensible language, unexpected terms, reservation of all power to the seller with nothing left for the buyer, and similar tricks and traps have no place in a well-functioning market.
How did financial products get so dangerous? Part of the problem is that disclosure has become a way to obfuscate rather than to inform. According to the Wall Street Journal, in the early 1980s, the typical credit card contract was a page long; by the early 2000s, that contract had grown to more than 30 pages of incomprehensible text. The additional terms were not designed to make life easier for the customer. Rather, they were designed in large part to add unexpected–and unreadable–terms that favor the card companies. Mortgage-loan documents, payday-loan papers, car-loan terms, and other lending products are often equally incomprehensible. And this is not the subjective claim of the consumer advocacy movement. In a recent memo aimed at bank executives, the vice president of the business consulting firm Booz Allen Hamilton observed that most bank products are “too complex for the average consumer to understand.”
Creditors sometimes explain away their long contracts with the claim that they need to protect themselves from litigation. This ignores the fact that creditors have found many other effective ways to insulate themselves for liability for their own wrongdoing. Arbitration clauses, for example, may look benign to the customer, but their point is often to permit the lender to escape the reach of class-action lawsuits. This means the lender can break the law, but if the amounts at stake are small–say, under $50 per customer–few customers would ever bother to sue.
Legal protection is only a small part of the proliferating verbiage. For those willing to wade through paragraph after paragraph replete with terms like “LIBOR” and “Cash Equivalent Transactions,” lenders have built in enough surprises in some credit contracts that even successful efforts to understand and assess risk will be erased by the lender’s own terms. So, for example, after 47 lines of text explaining how interest rates will be calculated, one prominent credit card company concludes, “We reserve the right to change the terms at any time for any reason.” Evidently, all that convoluted language was there only to obscure the bottom line: The company will charge whatever it wants. In effect, such text is an effort for lenders to have it both ways. Lenders won’t be bound by any term or price that becomes inconvenient for them, but they will expect their customers to be bound by whatever terms the lenders want to enforce–and to have the courts back them up in case of dispute.
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